Institutional Fraud: The Biggest Risk to Shareholder Value
A failure by most companies in Hong Kong to address all areas of the corporate fraud picture is leaving many exposed to what is potentially one of the most damaging types of fraud – institutional fraud.
Institutional fraud, also known as management fraud or “cooking the books”, has the potential to significantly damage ongoing company performance and shareholder value, and led to the collapse of several companies listed on the Hong Kong Stock Exchange in recent years.
Yet despite the widespread adverse impact institutional fraud can have on a company’s ability to survive in today’s challenging economic conditions, the detrimental impact of this type of fraud is only now starting to come under increased scrutiny as we continue to see more cases come to light.
CFOs are Aware of the Risks
My experience is that senior management is generally well aware of the risks and controls needed to protect the company against internal and external fraud.
For example, most companies have introduced systems and controls to prevent or detect a situation where employees commit fraud against the company for their own gain.
Companies understand that such instances could potentially bring about financial loss and reputational damage to the company. The same can be said about external fraud, where a third party colludes with employees of a company in order to reap monetary or commercial benefits.
However one of the most common oversights by senior management is in protecting the company from the occurrence of institutional fraud, which includes misrepresentation of the financial performance of companies.
This exposure can perhaps be attributed to the fact that those responsible for the design and implementation of the anti-fraud program could very well be the same individuals who could damage the company’s shareholder value.
Part of addressing this involves companies ensuring that a complete fraud risk assessment is undertaken, with significant input from the independent directors, as part of the creation and maintenance of their anti-fraud program and controls.
This is one of the steps that companies could adopt to mitigate the occurrences of institutional fraud – a step that we are not seeing enough of in Hong Kong.
This Happens in the US…
In May 2013, the US Rand Center for Corporate Ethics and Governance released a report that focused on delivering analysis and recommendations from a broad range of compliance experts, prosecutors, judges, accountants and government officials.
One of the key findings of the report was that, since 2002, the US Department of Justice has convicted 200 CEOs, 120 VPs and 53 CFOs of criminal misconduct. Another survey referenced in the same report suggested that in more than 4 out of 5 incidents of corporate fraud studied, the senior managers either knew about it or were the ones who committed it.
Whilst the examples highlighted refer to incidents in the US, the report reinforces how the issue has pervaded the largest developed global market, placing its shareholders, business partners, employees and senior management at risk.
…What About in Hong Kong?
So if these incidents can happen in the US, can they happen in Hong Kong? Yes and they already have, as too many companies are failing to look at the big picture when it comes to fraud.
And it seems that it is often the challenges and costs involved in developing a robust anti-fraud framework that are deterring companies from implementing such programs. But this has to change.
Companies need to think beyond the challenges and costs and consider how they can use a strong ethical culture to differentiate themselves from their competitors and stand out to investors.
But addressing the wider picture when it comes to fraud is not just about competitive difference. There is a definite business need particularly as we continue to witness the wide reaching enforcement of the Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act.
These two Acts mean that companies need to take action now and not tomorrow. They need to be conducting a complete fraud assessment together with a comprehensive anti-fraud program to ensure they don’t become unstuck should they be impacted by the FCPA or UK Bribery Act.
In October 2013 we saw Hong Kong Exchanges and Clearing implement stricter rules for companies listing in Hong Kong. In addition the Financial Services Development Council recently announced it is continuing to seek ways to improve the city’s financial markets.
Both these measures are signs that indicate Hong Kong’s regulators and business community want to stand out from other financial markets – demonstrating they want to create a robust forward looking business market.
But these measures in isolation are not proof of Hong Kong’s rightful place on the international financial stage. Companies need to play their part in building confidence about their operations and increasing shareholder confidence.
If companies in Hong Kong are serious about demonstrating how they protect shareholder value, they need to implement broad based anti-fraud programs that address all three different types of fraud: including internal, external and institutional.
If companies continue to focus on the wrong risks and neglect their duty to address the full fraud picture there is no doubt that shareholder value will be placed at risk.
It only takes a few companies to take the first steps towards more robust compliance and others will follow.
Let’s see if 2014 is the year that companies operating in Hong Kong set the standard for Asia when it comes to managing risk and ensuring shareholder value.
About the Author
Chris Fordham is Managing Partner - Fraud Investigation & Dispute Services, EY Asia-Pacific
This article summarizes complex issues and is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither the author nor the global EY organization or any of its member firms can accept responsibility for loss to any person relying on this article.
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